Question

6.   The following data refers to Company Z: -      Beta = 1.4 -      Required return on...

6.   The following data refers to Company Z:

-      Beta = 1.4

-      Required return on debt (yield to maturity on a long term bond) = 3.8%

-      Tax rate = 21%

-      30-year government bond = 1.5%

-      Market risk premium can be assumed to be 5%
Current Capitalization (Millions of USD)
Currency Million USD
Shares Price $                28.2
Shares Outstanding                    45.5
Market Capitalization               1,282.0
- Cash & Short Term Investments                    58.4
+ Total Debt               1,608.0
+ Pref. Equity                        -  
+ Total Minority Interest                        -  
=Total Enterprise Value (TEV)               2,831.6
Book Value of Common Equity                  571.7
+ Pref. Equity                        -  
+ Total Minority Interest                        -  
+ Total Debt               1,608.0
Depreciation & Amort., Total

              2,179.7

Estimate the cost of capital (WACC) for Company Z?

WACC = ?

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Homework Answers

Answer #1

WACC=(weight of debt*after tax cost of debt)+(weight of equity*cost of equity)

after tax cost of debt=Cost of debt*(1-tax rate)=3.8%*(1-21%)=3.0%

Cost of equity=risk free rate+(Beta*market risk premium)=1.5%+(1.4*5%)=8.5%

Market value of the debt=1608 million

Market value of equity=Outstanding shares*share price=45.5*28.2=1283.1 million

Total value=1608+1283.1=2891.1 million

Weight of debt=Market value of debt/Total Value=1608/2891.1=55.62%

Weight of equity=Market value of Equity/Total Value=1283.1/2891.1=44.38%

WACC=(55.62%*3%)+(44.38%*8.5%)=5.44%

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